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What Counts As a Business Expense if You Are Self-Employed?

What Counts As a Business Expense if You Are Self-Employed?
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Being self-employed is certainly an excellent way to earn a living, but it comes at the cost of needing to cover many expenses by yourself. 

Not only will you need to pay for any office space, transportation, and supplies related to your business, but you’ll also pay more in year-end taxes.

This can come as quite an unwelcome surprise and can eat into your bottom line. Fortunately, you can deduct some of these costs as business expenses to lower your tax liability! 

It’s important to note that this can get quite confusing because you’ll need to differentiate whether costs are for business versus personal purposes.

We’ll help you navigate this confusion below and point you towards some helpful deductions to save on your upcoming taxes!  

Many Expenses Are Deductible

The first thing you should know is that there are many expenses that you can deduct from your taxes. There are dozens of different costs that can give you a tax break.

Before getting into them, it’s important to understand how deductions work.

There are two primary ways of going about deductions. There’s the standard deduction that most people opt for and then there are itemized deductions.

The standard deduction is appropriately named because it offers a significant decrease in your taxable income ($12,200 for 2019). Just about any tax filer is eligible for it, making it the common choice for most taxpayers.

On the other hand, itemized deductions are far more complicated and are better suited for people that face significant, abnormal expenses during the year. These require you to individually list each expense, which is then totaled up to create your deduction.

The way you decide between the two is deciding which deduction is greater. More often than not, the standard deduction is a better option unless you face expensive medical bills or property taxes.

You might be wondering how this relates to deducting business expenses. Self-employed individuals get the standard or itemized deductions in addition to deducting business expenses.

This means that keeping track of your expenses is critical because it can offer you a massive tax break on top of what you already get to deduct.

Expenses Must Be Related to Business

One caveat to this benefit is that your expenses must be directly related to your business. Furthermore, any of these costs must be both necessary and ordinary.

Necessary costs include expenses that are appropriate and contribute to generating income. Ordinary costs are those that your average person working in your field would incur in the process of making a profit.

To put things into context, buying a new stereo for your home office or car is not deductible as a business expense. Alternatively, a new computer or tires can classify as a business expense if you need them for use in your business. 

However, you won’t be able to fully deduct these costs if you also use your computer or car for anything other than work. You can receive a partial deduction, but it is based on the percentage of use that is allocated to work.

This means that if you use your computer or car for work 8 hours a day, but then average out to computer or car use of 4 hours per day, you would be eligible for a deduction of ⅔ of the cost.

What Costs Are Eligible?

Putting this into context, your deductible business expenses will vary depending on what you do for self-employment.

If you operate as an online freelancer out of your home office, then your deductions will be limited to what you use in the office. This includes things like supplies, new equipment, or even the internet.

If you use your vehicle as a ride provider, then your deductions are restricted to car-related costs. Deducting expenses for a vehicle operates a little different because there are two ways to do this.

First, you can use car mileage as a method of determining the cost. This tends to be more straightforward because it makes the distinction between personal and work use clearer.

You’ll take the number of miles used for business purposes and multiply it by 58¢ to determine your deduction. You can also include any costs paid for parking and tolls.

The other method involves using actual cost, which is harder to determine but typically will result in a higher deduction. With actual cost, you’ll look at what you paid for gas, insurance, maintenance, and repairs.

Remember that either method requires you to look at usage that relates strictly to business purposes. The actual cost can get very muddy if you use the car for personal purposes, which requires you to only deduct the portion allocated to business use.

This comes down to determining how much the car is used for business against when it is used personally.

Regardless of what you choose to deduct, make sure that you are very careful with anything that is used for both business and pleasure. Do not claim full expenses if you use it outside of business as this is a quick way to get audited.

Closing Thoughts

If you operate as a self-employed individual, you should keep track of any expenses you incur for the operation of your business.

Many costs are deductible and will reduce your overall tax liability. These deductions can be taken in addition to what you receive from a standard deduction.

Whatever you decide to deduct must directly relate to your business and both ordinary and necessary.

You can deduct the cost of the items you use for both business and personal use, but you need to determine how much it is used for business and only deduct that portion.

The deductions you can claim will ultimately depend on what you do for work. An online freelancer will have different deductions from someone using their vehicle.

Since self-employed workers have higher tax rates, it is very important to keep track of expenses. This is the best way to protect your profits and ensure you get compensated for the necessary expenses!